The precarious State of the Union

The President’s State of the Union (SoU) address last week had a little something for everyone, contradictory policies, and not enough in any single area to make a difference in the economy.

First, there was something for everyone.  Bank bailouts are suddenly distasteful and the taxpayers need recompense for saving them; the Recovery Act (a.k.a. stimulus) “worked” and yielded two million jobs—although the official government web site still counts a mere 640,329, itself a dubious number with unemployment still over 10%; and the administration generally saved the country from the brink of disaster.  Democrats heard health care, climate legislation, restrictions on campaign funding by corporations; and Republicans heard capital gains cuts, nuclear power, and off-shore drilling.

Conspicuously absent from the self-congratulatory words was the role the Fed played in averting a depression by flooding the market with more money than that which is necessary for inflation-free growth.  Was it because the Administration did not wish to shine the spotlight on the Fed to assure Ben Bernanke’s reconfirmation last week?  The more probable answer is that, with the exception of Paul Volcker and Larry Summers, few in the administration, and most notably the President himself, understand the role of monetary policy and how the rate of growth in money supply can either catalyze or neutralize the effect of fiscal actions.

As long as the government continues to spend more than it receives and as long as the Treasury can sell U.S. debt and the Fed can print money to pay for the debt, it feels like the government is “stimulating” the economy.  But when the costs start to accumulate beyond reasonable manageability—in the form of higher taxes on future generations, a weak currency, and inflation, all three being correlated—the country may face periods of low growth or retraction or even default or a devalued dollar in the extreme.

Second, Obama proposed contradictory policies.  New fees on banks to purportedly make TARP whole attacks bank capital, hence lending, and do nothing to discourage risky behavior that originally spawned the program.  Shifting rescue funds to community banks signals to the market that only Washington will pick winners and that it will continue to bail banks out from imprudent lending.  Hoping for a “doubling of exports within five years” but neglecting to set a Kennedy style “moon-shot” objective for energy independence—say, by the end of this new decade—merely protracts an untenable reliance on imported oil.  Although Obama mentioned nuclear energy and off-shore drilling he did not acknowledge the plan to achieve energy independence that his National Security Advisor, General Jones, published during the transition.¹

Finally, the President’s proposals are riddled with half measures.  No one knows yet what he meant by proposing to eliminate the capital gains tax on small business, for example.  Most small businesses are partnerships or S-corporations whose earnings are taxed at the owners’ levels, and most small businesses need cash flow above all.  Therefore, it would have made more sense to propose lowering the marginal tax rate on income instead.  For larger corporations—those entities who have the privilege of paying tax twice on their income, once at the corporate level and once more at the shareholder level, and who, with Japan, pay the highest corporate taxes among the OECD countries, Obama might have proposed lowering the corporate tax to make the U.S. more competitive or even ending double taxation as his one time advisor, Robert Reich, proposes.

Markets need certainty of stability and businesses need hope for a more competitive cost structure.  Said in equivalent terms, both need government to reduce their respective financial burdens and move out of the way.  Obama offered neither, because he offers too much to too many.  And so we end up with a proposed budget as staggering as $3.8 trillion, 30% of the GDP, and a record deficit of $1.6 trillion.

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[1] A Transition Plan for Securing America’s Energy Future, Presented to President–elect Barack Obama and the 111th U.S. Congress, http://www.energyxxi.org/reports/Transition_Plan.pdf